OPTIMAL ASSET ALLOCATION WITH STOCHASTIC INTEREST RATES IN REGIME-SWITCHING MODELS

C. Ye (), R. H. Liu () and D. Ren
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C. Ye: Department of Mathematics, University of Dayton, 300 College Park, Dayton, OH 45469, USA
R. H. Liu: Department of Mathematics, University of Dayton, 300 College Park, Dayton, OH 45469, USA
D. Ren: Department of Mathematics, University of Dayton, 300 College Park, Dayton, OH 45469, USA

International Journal of Theoretical and Applied Finance (IJTAF), 2018, vol. 21, issue 05, 1-32

Abstract: This paper focuses on optimal asset allocation with stochastic interest rates in regime-switching models. A class of stochastic optimal control problems with Markovian regime-switching is formulated for which a verification theorem is provided. The theory is applied to solve two portfolio optimization problems (a portfolio of stock and savings account and a portfolio of mixed stock, bond and savings account) while a regime-switching Vasicek model is assumed for the interest rate. Closed-form solutions are obtained for a regime-switching power utility function. Numerical results are provided to illustrate the impact of regime-switching on the optimal investment decisions.

Keywords: Optimal asset allocation; portfolio optimization; stochastic control; regime-switching models; stochastic interest rate; power utility (search for similar items in EconPapers)
Date: 2018
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DOI: 10.1142/S0219024918500322

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